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The Recast EU Insolvency Regulation becomes effective today

Since May 2002, we have had a regime which ensures that an insolvency proceeding started in one of the EU’s member states is, without further formality, recognised in all other member states (except for Denmark) and which determines the law applicable to such proceedings. That regime is provided for in the EU Regulation on insolvency proceedings (1346/2000/EC) (the EIR).

With effect from today, 26 June 2017, the EIR is replaced by a recast regulation (EU 2015/848) (the recast EIR) and it marks the most significant legislative change in relation to cross-border insolvencies within the EU for over 15 years.

The recast EIR will apply to all insolvency proceedings commenced in an EU member state (except for Denmark) on or after 26 June 2017. The EIR will continue to apply only in relation to insolvency proceedings commenced before 26 June 2017.

The key changes made by the recast EIR (so far as corporates are concerned) include:

enlarging the scope of the Regulation so as to include certain specified pre-insolvency rescue proceedings, as part of a policy to encourage rescue and rehabilitation of debtors where there may be only a likelihood of insolvency;

the introduction of specific rules which may be engaged in relation to the insolvency of a multinational group of companies;

measures intended to discourage the use of secondary proceedings where a single main insolvency proceeding is seen as more appropriate;

lifting the restrictions so that secondary proceedings are no longer confined to being winding up proceedings;

removing the presumption that a company’s COMI is located in the jurisdiction where the company has its registered office in cases where the registered office has been moved in the previous three months;

certain other measures aimed at deterring what is seen as ‘bad’ forum shopping; and

paving the way for an EU-wide register of insolvency proceedings.

Background to the recast EIR

The EIR, which came into force on 31 May 2002, sets out insolvency recognition and conflict of law rules for the European Union (except for Denmark which exercised its right to opt-out). Most notably, the EIR ensures that a 'main' insolvency proceeding commenced in one member state (e.g. administration in the UK) will, without further formality, be automatically recognised in all other member states and the law applicable to that proceeding will be the law of the member state in which the proceedings were opened, subject to certain limited exceptions.

As an EU regulation, the EIR has direct effect in each of the participating member states and its interpretation is a matter of European law.

Its aims were:

to ensure that cross-border insolvency proceedings operate efficiently and effectively as part of a properly functioning internal market; and

to avoid incentives for parties to transfer assets or judicial proceedings from one member state to another in order to obtain a more favourable legal position.

The EIR is generally regarded as having been a success, aided by decisions of the Court of Justice of the European Union which have clarified certain concepts in the EIR and helped achieve uniformity of application of the EIR across member states.

It was originally intended that the functioning of the EIR would be reviewed after 10 years. After a consultation process and certain empirical studies, the result is the recast EIR. It is part of the EU's political aims to continue to promote economic recovery and sustainable growth, to encourage investment and survival of businesses.

Enlarged scope

The recast EIR has an enlarged scope in the sense that its provisions will be engaged in relation to certain pre-insolvency proceedings in member states, whereas the EIR applied only to each member state's traditional insolvency proceedings. The intention behind these changes is to encourage further the rescue culture as opposed to a culture in which companies with potentially viable businesses may be liquidated without first exploring other options.

The Recitals to the recast EIR provide that it should:

‘… extend to proceedings which provide for restructuring of a debtor at a stage where there is only a likelihood of insolvency ...' (Recital 10);

'... apply to procedures which grant a temporary stay on enforcement actions brought by individual creditors where such actions could adversely affect negotiations and hamper the prospects of a restructuring of the debtor’s business’ (Recital 11);

‘… extend to proceedings which are triggered by situations in which the debtor faces non-financial difficulties, provided that such difficulties give rise to a real and serious threat to the debtor's actual or future ability to pay its debts as they fall due’ (Recital 17).

The proceedings covered by the recast EIR are exhaustively listed in Annex A of the recast EIR. Note, for example, that the French mandataire ad hoc and conciliation proceedings are not listed, which we understand is on the basis that they are confidential proceedings.

Schemes of arrangement under English law are not listed in the updated Annex A, despite the efforts of certain other member states to compel the UK to add schemes to that list. We consider this further below.

Meaning of COMI confirmed

The recast EIR incorporates what European case law has determined is the meaning of ‘centre of main interests’ (a cornerstone of the EIR as it determines in which member state ‘main’ proceedings may be opened).

The following words which were in a recital to the EIR have been moved to be a definition in the recast EIR (Article 3(1)): "the place where the debtor conducts the administration of its interests on a regular basis and which is ascertainable by third parties". Furthermore, guidance given on the meaning of COMI in decisions of the Court of Justice of the European Union is summarised in the recitals to the recast EIR. As a result, it is confirmed for example that all factors must be reviewed comprehensively and special weight is to be attached to creditors' perceptions of where a company’s COMI is located.

Forum shopping

The recast EIR contains various provisions aimed at curbing what is seen as abusive COMI-shifting.

Under the recast EIR, the presumption that COMI follows the registered office will apply only if the registered office has not been moved to another member state within the three-month period prior to the request to open the insolvency proceedings. A similar three-month look-back test applies, under the recast EIR, to the definition of ‘establishment’, relevant to the opening of territorial (or secondary) proceedings.

Under the recast EIR, it is a new requirement that a court hearing an application to open main insolvency proceedings must, of its own motion, examine whether it has jurisdiction and it must specify the grounds for its finding.

More significantly, where an insolvency practitioner is to be appointed using an ‘out-of-court’ route, such as an appointment of an administrator in the UK by directors under paragraph 22 of Schedule B1 to the Insolvency Act 1986, the relevant IP will be required to specify the grounds on which COMI is the jurisdiction of appointment. The recast EIR leaves it to local law to provide for how and when such grounds are to be set out. In practice, we expect that in the UK this is likely to be another reason to apply for a court appointment in cases where a debtor’s COMI is thought to be located in a member state which is not also the member state in which its registered office is located.

The recast EIR also introduces an express right on the part of a debtor or any creditor to challenge before a court the decision opening main insolvency proceedings (Article 5).

In cases where COMI has purportedly been shifted from one member state to another, the EIR suggests (in Recital 28) that it may be necessary, for that shift to be effective and consistent with the meaning of COMI, that the debtor informs its creditors of the new location. This point is arguably more interesting for being an explicit acknowledgment that a shift of COMI can legitimately be achieved than it is for introducing a new requirement if COMI is to be migrated successfully.

Secondary proceedings

The recast EIR provides that secondary insolvency proceedings are no longer required to be limited to winding up proceedings (as were listed in Annex B of the EIR). This feature had been widely criticised as frustrating attempts to rescue group companies or divisions located in multiple different member states.

Furthermore, so-called 'synthetic’ (or virtual) secondary proceedings are expressly provided for in the recast EIR, whereby the relevant office holder may give a unilateral undertaking to the effect that local creditors, when it comes to distributions, will be treated as if secondary proceedings has been opened. The objective is to limit the cases in which secondary proceedings will be opened, in response to secondary proceedings broadly being seen as disruptive and an impediment to a rescue and/or an efficient realisation strategy. Known local creditors must approve the undertaking, such approval to be obtained in line with the local rules on the adoption of a restructuring plan. It remains a point of potential contention that, as a result, local creditors may enjoy greater rights than creditors in the main proceedings.

Article 36 which provides for synthetic secondary proceedings follows broadly the template established in the cases of Collins & Aikman and Nortel in which an administrator appointed in the UK undertook to respect local priorities of distribution in order to avoid secondary proceedings being opened in multiple different member states in respect of the same company.

The definition of an 'establishment' has been amended in the recast EIR, aimed at providing a solution to the problems encountered in the Olympic Airlines case. In that case, employees were excluded from the Pension Protection Fund because the English courts interpreted an ‘establishment’ as requiring that a market activity is being undertaken at the time secondary proceedings are requested. The recast EIR allows courts to assess whether an establishment existed in the three months preceding the opening of proceedings, which in the Olympic Airlines case would have provided a gateway to the PPF without the need for subsequent domestic legislation to deal with that particular case.

Cooperation and communication between courts and insolvency practitioners

In addition to the measures outlined above aimed at limiting the use of secondary proceedings, the recast EIR introduces provisions designed to encourage cooperation and communication between courts and IPs where there are or may be different proceedings and IPs in relation to the same debtor.

There is now a general obligation on the part of different insolvency practitioners appointed in relation to main and secondary proceedings concerning the same debtor to cooperate with each other and on the part of courts in different member states to cooperate and communicate with each other in order to facilitate the coordination of main, territorial and secondary proceedings concerning the same debtor, in each case to the extent not incompatible with local rules.

Groups of companies

A perceived shortcoming of the EIR has been its lack of any provision for the insolvency of multiple companies which are part of the same corporate group.

In response to this, the recast EIR introduces a new voluntary regime for groups of companies called ‘group coordination proceedings'. An independent insolvency practitioner (who is not already appointed over a group company) may be appointed as a ‘group coordinator’. His or her role is to propose a group coordination plan and as part of this he/she may mediate disputes, participate in proceedings, request information, and request a stay of up to six months if it is necessary to ensure the proper implementation of the plan and it would benefit creditors.

The court first seised is able to decide whether to commence such group proceedings, which may lead to there being a race to the courts. The choice of jurisdiction – as the court first seised - can be challenged by at least two-thirds of all IPs appointed to members of the group.

The disadvantage (or advantage, depending on your perspective) of this new group regime is its inherent optionality. Initiation of group coordination proceedings is optional; an IP appointed in respect of any group member cannot be compelled to participate in the group proceedings against his/her will (subject to the IP having obtained any approval that he/she is obliged to obtain as a matter of local law before objecting and provided that he/she gives reasons for objecting); and even if a company does participate, he/she is not obliged to follow either the recommendations or the plan (provided that he/she gives reasons for declining to comply in whole or in part).

While group proceedings have already proven successful in cross border insolvencies to date (e.g. Nortel), it remains to be seen whether the new regime will prove too cumbersome and prescribed to facilitate cross border cooperation within a corporate group. It is also worth noting that cooperation and coordination outside of the recast Regulation remains possible, and where there is a desire to cooperate, arguably this is as likely to be achieved outside of the new regime as will be within it.

New registers

The recast EIR sets out a requirement for member states to establish national registers of insolvency proceedings by 26 June 2018, to include certain core information about the proceedings.

As a second phase, applicable from June 2019, the intention is that a system be created to connect all of the member states' registers.

If and when it arrives, a pan-European searchable database of insolvency proceedings will be welcomed and is likely to improve the standards of national registers, including in the UK.

Brexit

The burning question so far as the UK is concerned is whether the UK will still benefit from the reciprocal benefits of the recast EIR after the UK leaves the EU, in March 2019 based on the current timetable.

Absent other arrangements being agreed, on exiting the EU, the recast EIR will cease to apply automatically between the UK and the remaining EU member states.

If no arrangements are made - which could be made as part of a withdrawal treaty or a series of bilateral agreements - the UK will be left to rely on an individual member state's private domestic rules for recognition of UK insolvency proceedings. The UNCITRAL Model Law would provide some assistance to UK-appointed officeholders but, thus far, only four of the current member states have adopted the Model Law (namely, Greece, Poland, Slovenia and Romania).

Schemes of arrangement

As noted above, the UK scheme of arrangement is not listed in Annex A of the recast EIR and, as such, schemes will continue to fall outside the ambit of the EIR.

The English courts’ extensive jurisdiction to sanction a scheme of arrangement in respect of an overseas company (now well-established by a long line of cases, such as Rodenstock) would have been significantly curtailed if schemes had been made subject to the recast EIR.

As schemes fall outside the Regulation, the English courts will be able still to assume jurisdiction over an overseas company for the purposes of sanctioning a scheme of arrangement without a company’s COMI necessarily being located in UK. On the flip-side, it will remain the case also that schemes will not be automatically recognised in other member states. Accordingly, recognition and therefore the effectiveness of a scheme in other relevant jurisdictions will still need to be considered and addressed separately.

Comment

On the whole, we think the recast Regulation is to be welcomed. It brings increased clarity and ought to result in better information and increased transparency generally, all of which our investor clients would welcome.

Some of the new provisions, such as those aimed at deterring the use of secondary proceedings and the new group process, could be said to codify what has already been happening quite effectively in practice. The provisions in relation to group proceedings, in particular, may be seen as too cumbersome and prescriptive to use and their attractiveness is undermined by the lack of compulsion as explained above.

Enlarging the scope of the Regulation to pre-insolvency proceedings was to be expected as part of the trend of favouring early intervention in relation to financially stressed companies. Stakeholders will have different views on that trend and the significance of this aspect of the recast EIR will remain to be seen in practice.

Compare jurisdictions: Restructuring & Insolvency

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